Take Advantage of Tax Season to Review Clients’ Beneficiaries

Author: Scot Macfarland, CFP®, CEP EA MPAS Financial Planning Consulting Manager, Wealth Management
03/15/2022

It’s tax time and many of your clients likely are reviewing their finances and considering tax implications of their investments and accounts. While these topics are top of mind for clients, it’s a good time to reach out and suggest they also take the time to review their beneficiary designations on their accounts. This exercise is a great way to add value to your client relationships while also getting more insights into their total assets and financial picture.

Accounts to Review

Certain types of accounts typically ask for primary and secondary beneficiaries, including:

  • Life Insurance Policies
  • Retirement Accounts (for example Roth IRAs, traditional IRAs, or 401(k) plans)
  • Health Savings Accounts
  • Annuities
  • Payable on Death (POD) banking accounts
  • Transfer on Death (TOD) investment accounts
  • Listed Trust Beneficiaries

Work with your clients to ensure they have assigned beneficiaries for all their accounts and that the person they intend to inherit their assets when they die is listed. For example, upon review, a client may discover that they still have an ex-spouse listed on an account who they don’t intend to receive their assets upon death. In other cases, they might have a beneficiary listed who has died. A review of beneficiaries at least annually – or following any major life events – will ensure the client’s assets are passed on to the right beneficiaries in the event of their death.

Spouse vs. Non-spouse Beneficiaries

It’s important to note that certain types of accounts – like 401(k)s – require individuals to list their spouse as their beneficiary. If your client would like to name someone else besides their spouse as a beneficiary, their spouse must sign a waiver.

However, before a client names another beneficiary – for example their children – to their retirement account, there are important implications to consider. Non-spouse beneficiaries are required to distribute the funds in the account within 10 years. Naming children instead of a spouse could lead to unintended tax consequences for the children. Spouses do not have this same requirement and follow the normal rule for taking distributions for the applicable account.

Insurance Beneficiary Considerations

Take special care when reviewing the beneficiaries for your clients’ life insurance policies. Both ownership and beneficiary designations should be carefully considered to ensure arrangements that may seem practical don’t have unintended income, gift, or estate tax consequences.

One common mistake with beneficiary designations for life insurance is called the Goodman Triangle. In this scenario, three parties are involved – the insured, the policy owner and a beneficiary of the insurance policy who is not the policy owner. In the event of the insured’s death, the death benefit may be considered a taxable gift from the policy owner to the beneficiary.

To avoid this scenario, always remember that two points of the insurance triangle should be the same person. The policy owner can also be the insured or the beneficiary, but a “rule of thumb” is that the insured should never be the beneficiary.

Consider Giving Minor Children Assets in Trust, Rather than Outright

Another important consideration is when you name minor children as a beneficiary. Your clients may want to gift assets to minors, but the manner they are made can have major implications for these types of beneficiaries.

Outright gifts to children or grandchildren have drawbacks, including limited control over the gifts made, exposure to creditors, divorce and other issues involving the beneficiary. Therefore, setting up a trust for the benefit of the child should be considered to offer greater protection and structure for the minor beneficiary.

Some trust options that may be considered include 2503(c) Minor’s Trusts and irrevocable gifting trusts. These trusts allow assets to be used for a wider variety of needs including medical expenses or the purchase of a new house, giving beneficiaries more options when they turn 21. Contact an attorney for details on how this will impact your client.

Reach Out to Clients in March and April

Now is the time to contact your clients to discuss beneficiary designations. It’s a great way to add value and open conversations with clients about potential opportunities to update older policies and accounts to other vehicles that may be more beneficial to them.

For more information about the tax implications of beneficiary designations, please contact me at scot.macfarland@hilltopsecurities.com.

To learn more about Momentum Independent Network, contact Wealth Management at WealthManagementInfo@hilltopsecurities.com or 833-4HILLTOP.

The paper/commentary was prepared by Momentum Independent Network (MIN).

Momentum Independent Network Inc. is a registered broker-dealer and registered investment adviser that does not provide tax or legal advice. MIN and HilltopSecurities are wholly owned subsidiaries of Hilltop Holdings, Inc. (NYSE: HTH) located at 717 N. Harwood St., Suite 3400, Dallas, TX 75201 (214) 859-1800, 833-4HILLTOP. Member FINRA/SIPC

For Professional use only.

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